Syndication: SEC Compliance

Syndication SEC compliance involves various rules and regulations investors must follow. Real estate syndication put simply is a group of investors pooling their money together. They use the capital to purchase and manage real estate that is usually beyond their ability to acquire independently. 

The investors form a legal entity like an LLC to buy and manage the real estate. Investors receive profit in proportion to their investment from the following: 

• Rental income
• Property sale

Watch the Royal Investing video featuring securities attorney Stephen Slawinski who specializes in helping real estate sponsors raise capital and stay compliant with the SEC. 

What Is SEC Compliance?

The U.S. Securities and Exchange Commission (SEC) sets regulations and laws that investors must follow. The laws protect investors from fraud and ensure that publicly traded companies provide accurate financial information. Companies file reports with the SEC to demonstrate their compliance. 

Rules And Regulations For Syndicates Under The SEC

The SEC requires syndications to comply with laws concerning securities selling. Syndications remain compliant by following the regulations controlling private placements found in SEC Regulation D. 

Rules And Regulations

Strict rules control a syndication's organization and property transfer. Additional SEC rules for real estate syndicates include the following: 

• They must fully comply with SEC Regulation D
• 35 or fewer non-accredited investors
• Forbids syndicate referral payments for anyone other than SEC-registered brokers
• Non-accredited investors receive additional disclosures
• Real estate brokers operating a syndicate must understand the difference between securities and non-securities
• Sponsors must provide offering documents  

Syndication: Securities And Non-Securities 

Securities represent financial value and can be traded on a public exchange: stocks, bonds, and options. Non-securities are investments not typically sold on a public exchange, like art and some real estate.

The syndicate's structure determines if your investment is a security or a non-security:

• Limited partnership structures usually receive units classified as securities
• LLC structures may receive non-security units

The significant difference is that securities must follow SEC regulations, while the same rules do not bind non-securities.

SEC Compliance: Registration, Exemptions, And Deal Structures

Four acts affect syndications. We'll discuss each and how to avoid the implications of each act. 

Securities Act Of 1933

Under this law, it's unlawful to sell or offer to sell a security without registering the security with the SEC unless the security is exempt from registration. 

Avoid the implication by:

• Structuring it so it's not a security.
• Ensuring all partners have active roles.

Exemptions under Regulation D, Rule 506(b):

• Raise unlimited capital
• Up to 2,000 accredited investors and 35 non-accredited investors
• Self-certify as accredited or non-accredited
• Cannot advertise

Exemptions under Regulation D, Rule 506(c):

• Raise unlimited capital
• Up to 2,000 accredited investors
• Accredited investors only
• A reasonable attempt at verifying the accreditation status
• Can advertise

Securities And Exchange Act Of 1934

This law makes it illegal to "effectuate" the sale of a security or accept compensation for the sale of a security as an unregistered broker-dealer. 

The implication is difficult to avoid because selling interests to your company or passive investors is probably "effectuating" the sale of a security. 

Exemptions to this rule appear in Rule 3a4-1.

The Investment Company Act Of 1940

This law stipulates that a company "engaged … in the business of … trading securities" must register with the SEC. 

Avoid the implication:

• Avoid trading securities.
• Ownership of real estate is not a security.  
• Section 3(c)(1) exempts a company from registering if it has less than 100 investors.

The Investment Advisor Act of 1940

The law dictates that acting as an investment adviser is unlawful without registering with the SEC. 

Avoid the implication with a direct ownership interest in real estate.

Exemptions:

• Managing less than $150 million in assets OR
• Advising private funds

SEC Compliance: Syndication Structure

JV Structure

Property owned by

• Special Purpose Entity comprised of
  • Capital or Active Partner
  • Sponsor Partner

 The structure might not be a security if each partner has an active role. If it isn't a security, no other security laws apply. 

Basic Deal Structure

Property owned by 

• Syndication Entity (LLC) comprised of
  • Investors
  • Sponsors
• Management Entity (LLC) comprised of
  • Members of Management Entity (Sponsors)

A basic deal structure helps with the acts in the following ways:

• Securities Act of 1933–implicated with an exemption as long as you follow Regulation D
• Securities and Exchange Act of 1934–implicated with an exemption as long as each sponsor has an active role in the business other than fundraising
• Investment Company Act–exempt because you're dealing with real estate, not securities
• Investment Advisor Act–not implicated as sponsors are not advising investors on securities

Watch the video to learn more about the Fund of Funds structure.

SEC Compliance Key Takeaways

Deal structure impacts SEC legal compliance requirements. The SEC has a specific definition for what constitutes security and non-security. When investing in a real estate syndicate, you'll want to:

• Avoid the implications of securities
• Register with the SEC
• Find an exemption to registration 

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